Fed’s dovish policy will not erase carry trade risks in Hong Kong dollar, analysts say
- Hong Kong dollar jumped to 7.8451 against the US Dollar on Thursday, its strongest level in six weeks to pull away from the weak end of its trading band
- The US Federal Reserve earlier brought its three-year drive to tighten monetary policy to an abrupt end, abandoning projections for any interest rate hikes this year
The Hong Kong dollar’s rebound on Thursday after the US Federal Reserve surprisingly decided to halt its interest rate increases will only be temporary because traders will continue to exploit the gap between Hong Kong and US market interest rates trade activities conducted by traders as global central banks turn to similar looser monetary policies to combat the global economic slowdown, analysts said.
Given that Hong Kong’s de facto central bank runs its interest rate policy in lockstep with the Fed to maintain the city’s currency peg to the US dollar, Hong Kong’s benchmark interest rate will match the pause in US rate increases.
But the city’s short-term interbank banks rates have remained well below their US counterparts this year because of lukewarm loan demand due to last year’s cooling property market and lacklustre investments amid the US-China trade war and have left banks flush with liquidity, keeping the cost of money low.
The one-month Hong Kong interbank offered rate (Hibor), a gauge of banks’ funding costs, is down more than half a percentage point so far this year to 1.68 per cent after climbing more than a percentage point last year. In contrast, the one-month London Inter-bank Offered Rate (Libor) has stabilised around 2.49 per cent this year, leaving the difference between the Hibor and Libor rates at almost a full percentage point, a very large gap in bond market trading.
The gap between Hong Kong and US market interest rates is the key reason investors engage in what is known as the carry trade – selling the lower-yielding Hong Kong dollar and buying higher-yielding US dollar-denominated assets. Given the size of the gap between the Hong Kong and US rates, the trade has been very lucrative lately.
At Wednesday’s meeting of the Federal Open Market Committee (FOMC), the federal funds rate target range remained unchanged at 2.25 to 2.50 per cent, and projections of 2019 rate increases were scaled back to zero from two. It was also announced that the Fed would stop in September selling off the securities it bought during its response to the global financial crisis a decade ago, which will leave bankers will more money to lend.
“The decision of FOMC meeting suggests that the Fed will slow down the pace of hiking interest rates and end its balance sheet run-off in September. However, as interest rate differentials between [Hong Kong dollar] and [US dollar] remain, there are still incentives for funds to flow from [Hong Kong dollar] to [US dollar],” said Hong Kong Monetary Authority (HKMA) chief executive Norman Chan.